July 2018

Pan European property shares extended their gains in July, with the benchmark (FTSE European Public Real Estate Association/National Association of Real Estate Investment Trusts (EPRA/NAREIT) Developed Europe Index total return in sterling) rising 2.1%, bringing the financial year (31 March) to-date performance up to 8.2%. The fund’s total return in July was 2.8%, exceeding the benchmark by 68 basis points (bps).

It is interesting to note that the same index when viewed in euros rose just 1.2%, which illustrates the impact of the weakening pound. The currency exposure of the portfolio constantly matches that of the benchmark, with sterling exposure currently just 28%. Weak sentiment towards the UK stretched beyond just the currency, with UK property companies significantly underperforming (-0.6% in sterling) versus their Continental cousins, where total returns were 2.3% (in euros) over the month.

The weakest cohort in the UK was, once again, the retail focused businesses. We have been concerned for some time that the lack of transactional evidence for shopping centres investments has led to independent valuations remaining artificially elevated. Landsec down valued its Bluewater asset in March (reported in May) but has now been joined by Intu, which announced a +33bps yield expansion and -2% estimated rental values leading to a -6% asset write-down over six months. This, with an excessive balance sheet leverage, led to a -12% net asset value (NAV) decline, and CEO David Fischel stepped down. We continue to believe that the company’s uncovered dividend should be rebased in light of the structural headwinds facing the UK retail sector. The impact of company voluntary arrangements by weak tenants, as well as estate downsizing by healthy ones, is resulting in a steady downwards grind in rental values. Hammerson announced its pre-flagged strategic review with nothing new and the stock failed to respond to the news (price 510p). We were surprised that Hammerson’s asset value did not correct more given its announcement that it will be selling out of its retail warehouse portfolio. We think the Board and management have many questions to answer given that they rejected Klepierre’s 635p offer just two months ago. Retail’s woes are not confined to the UK: Dutch real estate company Wereldhave’s valuation and rental income both continued to decline (by approximately -1%), highlighting the unprecedented pressure for secondary shopping centre landlords in markets that have been stable for so long.

The other side of the retail ‘coin’ remains warehousing and logistics and this reporting season reinforced the now incontestable theme of ‘sheds being the new shops’. Segro, the largest specialist in this sector reported accelerating results with 2.3% LFL rent growth, 11% EPS growth and 8.5% NAV increase over six months. Many of our other warehouse exposures also had a strong month with Catena +7.7%, WDP +5.9% and Argan 6.2% all fuelling relative performance.
Sweden was the standout regional performer in the month, with a total return of 11.6% in Swedish krona terms. This was fuelled by the largest Swedish office developer Fabege (the seventh largest overweight), which reported consensus-beating results for the first half of 2018 and raised its annual investment amounts to SEK2.5bn (from 1.5bn). The results showed an outstanding operational performance, with 5% like-for-like net rental growth (roughly 10% including capital expenditure), 29% uplift on renegotiated rents and 9% capital value growth. This led to a 15% NAV increase over six months. We remain positive on Stockholm offices: the strong economic backdrop is translating into solid office job creation, which, coupled with the short average office lease duration, is leading to very favourable market conditions for landlords with falling vacancy rates and very high rental growth.

Norway’s only listed index constituent is Entra, which is focused on Oslo offices. The stock has been a solid overweight and performed well in July, returning 7.0% as investors focused on its development pipeline, as well as the positive picture of demand (resurgent oil price) and limited supply.

During the month, we received the cash proceeds (equating to 4.4% of NAV) from the takeover of Hispania by Blackstone. We expect that there will be further opportunities to redeploy some of this capital into new Spanish assets in Autumn. In the meantime, the portfolio gearing (the level of debt related to equity capital) has reduced to approximately 12%. August is often a volatile month given reduced trading volumes during the peak holiday period, and receipt of this and the slightly reduced gearing is timely.